When Worlds Collide

Email this article

To*

Please enter your email address*

Subject*

Comments*

Fior time immemorial, China has furnished foreign yarn-spinners with tales of epic battles. Now, as capitalism takes hold, a literature is emerging devoted to the conflicts of business. Books such as China Dream by Joe Studwell, and the newly released Mr. China by Tim Clissold—former CFO of Asimco, a company managing many China joint ventures—chronicle no-holds-barred struggles between enlightened capitalists and xenophobic Chinese managers. While they make compelling reading, they can lack the more complex shadings of the local point of view. And they tend to overlook a key player, the Chinese finance professional charged with making the enterprise work.

Xu Saihua’s experience as the foreign-appointed CFO in a Chinese joint venture could have been written by John Grisham, the US bard of corporate intrigue. Her story also highlights the role of an unsung combatant in China’s business culture wars. Xu, a Shanghai lawyer, was tapped by Gale Pacific, an Australian maker of outdoor knitted fabrics, to monitor the finances of Gale’s manufacturing in Ningbo, a city south of Shanghai. She turned out to be the foreign investors’ angel who ensured that the investment stayed afloat in an environment of conflicted loyalties. Says Xu: “I do not really know how I came through,” but she quickly gathers herself and adds: “Looking back, I can see there were conflicts of interest between the two parties, as well as conflicts of principles.”

Recommended Stories:

Xu’s story shows the level of risk that foreign companies undertake when launching a joint venture in China. During her embattled tenure, Gale Pacific bought out the joint venture partner and turned the enterprise into a wholly-owned foreign enterprise (WOFE). A preference for WOFEs, and therefore greater control, reflects the general trend in China, where struggles within joint ventures—and an easing of investment laws—have made total ownership more popular.

But there are still 285,000 registered joint ventures in China, and some multinationals prefer to go this route. One reason may be profitability. McKinsey, the US-based consultant, launched a study last year that found that among the 31 foreign multinationals it polled, each with WOFEs and JVs in its portfolio, the joint ventures had fared better. But the study also found that the ultimate success, whether WOFE or JV, depended on the presence of a local finance officer with the independence to act in the majority shareholders’ interests.”

Lawyer Turned CFO

McKinsey might have added, get a local lawyer like Xu Saihua to be finance chief. Prior to taking her CFO job in Gale Pacific, Xu, 30, was an attorney with a Shanghai firm, specializing in business investment and merger and acquisition advisory work. Gale Pacific was one of her clients. Then, in late 2002, Gale Pacific acquired US-based California Sun Shade.

A private enterprise in Ningbo owned by a local businessman named Lu Xianfeng, 35, was the sole supplier of raw materials to California Sun Shade. (Repeated attempts to interview Lu for a response to this story were declined.) In order to secure a continuous and cheap supply of materials, Gale Pacific’s managers negotiated a JV deal with Lu. In the deal, the Australian side would invest US$1.9 million and own 85 percent of the JV; Lu would invest US$330,000 to take the remaining 15 percent. As a minority shareholder, Lu became a director of the JV, Gary Gale, Gale Pacific’s managing director, became chairman of the board. Gale Pacific also appointed an independent director to balance the board.

Beginning October 2002, Xu worked closely with Gary Gale, her then legal client, to get the Ningbo JV up and running. The JV was registered in Ningbo Economic and Technology Development Zone (NETD), and the authorities there drafted a land lease contract with it. “Xu had only a glimpse of the contract and pointed out that it was illegal,” Gary Gale recalls. Xu explained in detail how the clauses on dispute resolution in the contract violated current laws. Both parties were convinced and quickly made changes to the contract.

Her job done, Xu returned to Shanghai. “In early December 2002, the Chairman (Gary Gale) suddenly rang from Ningbo and asked whether I would like to work for him,” she recalls. Why leave Shanghai for Beilun, a suburb some 40 kilometers from downtown Ningbo? “Of course I got a decent package,” says Xu.

“But it was more [to work with] the chairman.” Xu says Gary Gale “is reliable, knows about China, is smart, and treats people well.” Xu thought then that Gale would want her to assume the role of legal counsel, or take on other administrative responsibilities. Therefore it surprised her when she arrived at Ningbo to find she was to be the CFO. Why appoint a lawyer to be the CFO of a JV? Gale answers: “China is very bureaucratic and laws are very important.”

Unwelcome

Xu found she was unwelcome from day one. The first project after the JV completed its registration in December 2002 was to purchase equipment and raw materials. Sunshade products are seasonal and the company needed to deliver products to the US market as early as January 2003. Because time was so tight, the company decided to purchase equipment and inventory from Lu’s former company. Xu took on the job of selecting and verifying the quality of the equipment and stock offered by Lu. Xu says that she questioned the usefulness of some of the equipment, and immediately earned Lu’s displeasure. “I was very careful while questioning him,” she says, “but Lu was still very uncomfortable, simply because his reasoning was that being asked questions equaled being distrusted.”

Despite this, Xu and Lu pressed ahead and sealed a deal for the purchase. Both parties worked hard to kick-start production. “It was really cold and Lu worked overtime with the workers all the way through,” says Xu. By the end of December 2002, the company was up and running smoothly and sales started in January the next year. What’s more, the company was profitable in that very first month. “Lu played a significant role in getting the factory operational, realizing sales and profitability in such as short time,” says Xu.

But she says she also sensed that her presence “increasingly discomforted Lu.” As a legal counsel for JVs, Xu understood corporate governance to involve checks and balances. “Running a company needs rules and processes,” she says. However, Lu was someone “with a strong view on management, who insisted on doing things his way.”

In early February 2003, shortly after the JV started normal operations, Lu took advantage of his role as one of the company’s directors and called a staff conference. He announced that, from then on, he would decide on his own who would be put in charge of purchasing and human resources. With regards to finance, “he pre-arranged everything, including how I should make financial accounts, who should enjoy what allowances, and even how many times a certain employee could reimburse travel expenses for visiting his family in another town,” says Xu. She felt this was a serious matter and sent a memo in protest to Gale Pacific’s board in Australia.

The conflicts with Lu intensified. Lu fired off a long letter to the Australian headquarters. In the letter, he argued that Xu was not qualified to be a CFO and called for her removal. Xu believes that this was not a personal attack but that Lu was against the role of the CFO in principle. He regarded the position as an excuse to watch his every move. “He thought everything I did was against him,” says Xu. As for the long list of her “wrongdoings” in Lu’s letter, which she read later, Xu is dismissive. For example, Xu cites a complaint by Lu that she did not pour tea for him, a traditional display of respect in China.

Gale Pacific’s board took Lu’s complaints seriously. The investigation was so emotionally wrenching that Xu considered resigning and going back to Shanghai. “However, if I quit,” she says, “I could foresee that the Australians would have to give up more interests.” As it turned out, the Gale Pacific board concluded Lu’s claims to be unfounded. Nevertheless, Lu still insisted on firing Xu. Either Xu leaves, he said, or he exits with his stake. But the Australians took a hard line, too. Lu could go, but Xu had to stay. After some negotiations, Lu proposed to have a month’s time to weigh the issues, and then decide whether he wanted to continue the partnership.

Certainly, not all conflicts can be resolved peacefully—indeed some call for draconian measures. But decisions on changes to business process, especially in organizational structure—such as restructuring units and reducing staff—have to be supported by top management. “After ERP implementation, some units will unavoidably disappear, while others will undergo restructuring and job positions will be cut. These decisions need to be made by the head of an organization. The key role that top management plays in ERP implementation,” says Zhang, “is to support it unreservedly.”

Isolated and Helpless

Shortly after appointing Xu as the CFO, Gale Pacific’s board also designated Yang Yineng, a 33-year-old Australian born in China, as the general manager based in Ningbo. As part of the newly created post, both Lu and the CFO reported directly to him. It was Yang, and his collaboration with Lu, that forced the crisis that eventually broke the partnership.

In May 2003, the joint venture set out to build its own plant. Prior to this it had been leasing local facilities. Lu selected the contractor, and won the general manager’s backing, but Xu objected. The investment planned for the new plant exceeded 20 million renminbi (US$2.4 million), and Xu thought the cost too high and the contractor below standard. Xu drew up a comparative analysis of contractors that bid for the project and, along with experts’ reviews, sent it to Gale, who decided to launch an independent field inspection. Gale eventually concluded that the deal was too costly and decided against using the contractor. Immediately afterward, Yang left his post and Gale Pacific.

Upon hearing the news, Lu, still cooling off and on a trip to the US, flew back to Ningbo, called a staff meeting and announced that he would take over the company. He asked Xu to turn in the company chop and surrender key documents. Xu refused. Lu forced open the door to Yang’s former office and declared he was the new general manager. Xu also went on the offensive, immediately hiring a lawyer from Shanghai and a local security service to safeguard the company’s assets.

The stand-off lasted until mid-June, when Gale Pacific chose its own contractor to build the new plant. Lu announced he was withdrawing his shareholdings. However, the two parties could not reach an agreement on who owned the shares of several interests. Nor could they settle on a non-competition agreement, with the Australians demanding that Lu not compete with the company after withdrawing his holdings. Zhang Ruping, NETD’s Vice Merchants bureau director recalls: “Both parties were going over the top. The gap between them on the terms of termination of the JV was huge.” NETD officials attempted to bring both parties together, and after many rounds of talks, an agreement was finally reached in September. Lu would withdraw his shareholdings and was entitled to his share of the profits when the company was operating as a JV. But going forward, the JV would become a WOFE. When this happened, Xu had been in the CFO chair for a mere ten months.

Was the JV doomed from the start? Gale says he intended to work with Lu for the long term. However, NETD’s Zhang says that Lu had expressed his suspicion of the Australians. Lu thought that the Australians planned all along to form a JV first, then force him to give up his shares, step by step. Xu disagrees.

“Foreign direct investments are for the long term,” she says. Still, judging by the outcome, Lu can be forgiven for having that impression. The initial joint venture was indeed “a free marriage”, to use the words of Zhang, but the parties were unequal, in terms of capital invested. The Australians, as the majority and controlling shareholder, quickly moved to exercise their will by way of designating the CFO and general manager of the JV. Xu says she attempted to communicate with Lu and emphasized repeatedly that what she was doing was for the benefit of the JV. However, Lu would not listen because in his eyes, Xu represented the foreign interests only. Xu acknowledges as such. “So long as the basic principles were not violated,” she says, “I had to put the interest of the majority shareholder first.”

Last September, Xu was appointed a director of the board of the WOFE. She suggested that the company consider expanding in the China market, rather than just using Ningbo as a manufacturing center and exporting everything. Xu is now overseeing the building of a new plant and opening a Shanghai representative office, laying the ground for launching sunshade products in China. The company remains profitable, with earnings of 4 million renminbi (US$459,000) on 49 million renminbi in sales.

Cultural Divide

Looking back, Xu says she now realizes the inherent conflicts of interest in the JV. Lu had provided a portion of equipment and inventories, thus playing the roles of both supplier and shareholder. The situation was exacerbated by differences between the cultural backgrounds of the two parties. “The Chinese party cared very much about face. He demanded respect and 100 percent trust. He just could not deal with any questions,” she adds.

Zhang followed the JV project between Gale Pacific and Lu all the way through, and many times mediated between the parties. Zhang also believes that the final divorce to a large extent could be attributed to the differences between the mindsets of the two parties. But unlike Xu, Zhang is more inclined to think that the foreign party erred in underestimating the problems of crossing the cultural divide in China. “Generally speaking, foreigners still know very little about China,” he says.

Yang Jian is a senior writer for CFO China in Shanghai.

Lessons from the Field

Xu Saihua, a lawyer before she joined Gale Pacific Special Textiles (Ningbo) in 2002 as CFO, has represented both foreign and local partners in disputes over joint-venture arrangements. She attributes conflicts between Chinese and foreign investors in long-term business relationships to a couple of primary causes: the lack of a commercial culture in China and different perceptions about how promises should be honored.

In the simplest terms, Xu says, Chinese are serious about promises but tend to trifle with contracts; foreigners are serious about the contracts but less so on promises. The lack of due respect for the black-and-white wording in legal documents frequently becomes the first cause of discontent in a joint venture. What often happens is that when foreign JV partners drag the disputes into the courts, the local partners often feel at a disadvantage—because they know they have violated the letter of the contract.

In the case of the battle at Gale Pacific, the local JV partner, Lu Xianfeng, shied away from hiring a lawyer at the outset despite the advice of Xu and local economic-zone officials. He agreed to the terms on paper anyway, on the basis of his understanding of his partners’ promises. He eventually rebelled against the agreement when he felt it put too many constraints on his management of the company’s daily operations.

Beyond the legal issues, Xu cites a more general problem: a cultural resistance in smaller Chinese companies to the idea of the independent CFO. While this may not be the case in major companies—Legend and Haier being two examples—it is true for smaller JVs and even wholly owned foreign enterprises (WOFEs).

A CFO who questions the decision of a local manager is regarded as showing disrespect, bringing about a loss of face. Xu believes that the modern idea of CFOs as accountable to shareholders rather than to company executives will eventually be accepted as Chinese business continues to evolve. For now, CFOs who accept positions in alliances between foreign and local partners may, like Xu, find themselves pivotal figures in unexpected conflicts.